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Rectification applications: rethinking notice to the CRA after Brogan

Whether a taxpayer should put the CRA on notice of a pending rectification application is a somewhat contentious question. In Income Tax Technical News No 22 (January 2002), the CRA stated that if “not properly informed about the rectification application, [the] reaction will be to contest the rectification order in Provincial Court.” However, at the 2005 Canadian Tax Foundation Conference, the CRA clarified that it would not challenge a rectification order solely for lack of notice, but would challenge if rectification was considered to be abusive.

Courts’ views of whether it was necessary to notify the CRA go both ways, but seem to turn on the extent to which the CRA’s interest had been crystallized. In Prospera Credit Union (Matter of), 2002 BCSC 1806, the Court allowed the application to proceed without notice to the CRA, having accepted that the CRA was not a creditor and would only be affected in the sense of losing an unexpected windfall if rectification was granted. In cases requiring notice to the CRA, the taxes payable appear to have been assessed (Columbia North Realty Company, Re, 2005 NSSC 212) or the transactions were specifically structured to obtain tax incentives (Snow White Productions Inc v PMP Entertainment Inc et al, 2004 BCSC 604). In Aim Funds Management Inc v Aim Trimark Corporate Class Inc, [2009] OJ No 4798 (“Aim Trimark”), the Court allowed the CRA to intervene. The Court offered some general guidance, stating that to “avoid opening the floodgates” to CRA participation in all rectification applications, the CRA should be added when it has established its position as a creditor by assessing, or where all parties are aligned in interest with the result that no adverse party would be present to test the evidence. The Court stated that the CRA would not always have a right to intervene even where it satisfies both criteria, nor would intervention be limited to situations only where those two criteria are met. Each case needed to be decided on its own facts, in accordance with the Court’s discretion.

The debate about notice to the CRA and standing before the Courts was advanced by the recent Ontario judgment on a motion to set aside a rectification order in Canada (Attorney General) v Brogan Family Trust, 2014 ONSC 6354 (“Brogan”). The background in Brogan was as follows. In 2004, Tom Brogan settled a trust in the course of reorganizing his business. In 2010, an error was discovered in the trust instrument that would have prevented the distribution of trust assets to minor beneficiaries and the trustees of the trust retained counsel to rectify the trust instrument. Counsel advised that they could seek rectification without notice to the Crown. The application proceeded without notice and a rectification order was issued to correct the trust instrument. Shortly before the rectification order was granted, the trust sold a business and the trust and its beneficiaries reported in their 2010 income tax returns the allocation of proceeds from the sale of the business. In June 2012, the CRA audited the trust in respect of the business sale and subsequently became aware of the rectification order. Ultimately, in May 2013, the Crown filed a motion to set aside the rectification order (the delay in bringing forward the motion was attributed to internal office confusion and the auditor initially not being aware that the order was obtained without notice).

The motion to set aside the rectification order turned on the issues of whether: the CRA had standing to bring the motion as a party “affected by a judgment”, as required by the Ontario Rules of Civil Procedure; the CRA brought its motion “forthwith”, as required by the Ontario Rules; and whether the respondents breached a requirement to notify the CRA of the rectification application.

The CRA had to demonstrate it was a party that would be affected by the judgment, which means demonstrating that its proprietary or economic interests were involved. From the CRA’s perspective, the rectification order eliminated a tax liability, thus affecting its rights. On the other hand, counsel for the trust argued that rectification merely corrected a lawyer’s error. The Court did not accept that the tax liability was established upon the sale of the business, or that the filing and assessment of a return was merely a calculation exercise of an existing tax liability, as argued by the Crown. The Court interpreted Aim Trimark as standing for the proposition that the CRA may be affected by a judgment when it is a creditor, by way of having made a tax assessment. The Court explained that according to Aim Trimark, the CRA’s participation would be allowed to ensure that a motions judge would decide a rectification application on “convincing evidence” and that the “stringent” standard of proof would be limited to cases where the CRA is a creditor.

The Court also held that the CRA did not bring its motion forthwith as required by the Ontario Rules. The CRA auditor reported to a group within the CRA that included people knowledgeable about rectification. Further, even after the issue was detected, it still took two months for the CRA to launch the motion. In the Court’s view, these factors supported the conclusion that the CRA did not act diligently.

Finally, the Court held that there is no authority for the proposition that the CRA must be given notice in every rectification application and no authority that notice is required in the absence of the CRA being a creditor or having a vital interest in the outcome. The Court confirmed that by assessing or reassessing the CRA creates rights as a creditor. However, the tax intention underlying a transaction is not driven by the assessment or reassessment and, in the absence of an assessment or reassessment, notice to the CRA may not strictly be required. The Court stated more definitively than Aim Trimark that the CRA is only entitled to notice when its legal rights might be directly affected by the outcome, such as where it is a creditor. Although the Court did not expressly say so, one might reasonably extrapolate from this reasoning that cases involving refundable tax credits would similarly affect the CRA’s economic interests.

Brogan may be considered good news for taxpayers and their advisors, insofar as proceeding without notice to the CRA may streamline or expedite the process. However, in our respectful view, although counsel may seek to rely on Brogan in the future, it is an open question whether all of the analysis is correct. There are clear authorities from the Tax Court of Canada and Federal Court of Appeal confirming that the Crown’s right to tax arises at the time of a transaction and not at the time that a tax return is filed or assessed, although it may be argued that according to Markevich v Canada, 2003 SCC 9 a tax liability crystallizes after a notice of assessment is sent.

Further, comments in Brogan regarding the standard of proof in rectification cases are debatable. In Performance Industries Ltd v Sylvan Lake Golf & Tennis Club Ltd, [2002] 1 SCR 678 (“Performance Industries”), Binnie J wrote of a standard of proof that fell between the criminal and civil standards. However, subsequently in FH v McDougall, 2008 SCC 53 (“McDougall”), the Supreme Court of Canada held that in civil cases there was only one standard of proof, namely, the balance of probabilities. Whether Performance Industries was specifically overruled by McDougall was potentially uncertain, since McDougall was not a rectification case. However, in McLean v McLean, 2013 ONCA 788, the Ontario Court of Appeal held that McDougall overruled Performance Industries. Consequently, one might reasonably criticize the judgment in Brogan for referencing “convincing” or “stringent” standards of proof. Having said that, the Alberta court in Graymar Equipment (2008) Inc. v. Canada (Attorney General), 2014 ABQB 154, held that even though the standard of proof remains the balance of probabilities, there would have to be compelling evidence to overcome the presumption that the parties’ intentions were properly recorded in their written instruments.

Time will tell how Broganmay affect the evolution of rectification principles.

As of the date of this article, the appeal period has not expired but to-date this case has not been appealed.